RMBS Surges 12%: JP Morgan Ups to Buy, Risks Priced in

By Tiernan Ray

Shares of memory chip interface designer Rambus (RMBS) are up 47 cents, or almost 12%, at $4.54 after J.P. Morgan’s Paul Coster today raised his rating on the stock to Overweight from Neutral, with a $7 price target, arguing that after a 46% fall this year through Friday’s close, the shares are “de-risked.”

At $4 to $5, writes Coster, the shares are supported by contracts in the bag for Rambus’s semiconductor business group, by cash on hand of $212 million, and the break-up value of LED lighting technology and its cryptography division, CRI. A settlement with South Korean chip maker SK Hynix (000660KS) could offer further upside.

Coster maps a scenario in which semiconductor revenue winds down as Rambus’s contracts expire, but new businesses grow, including a break-up scenario:

Scenario 1: We assume SBG revenues decline to $0 in 2015 when most licensing agreements are set to expire, that the NBG segment increases 15% annually (off a low base) through 2020 and at 5% in perpetuity, capex declines from ~$20mm to ~$5mm annually beginning in 2015, and EBITDA margins gradually improve primarily owing to reduced litigation expenses. This scenario yields a DCF of $4.02 per share. Scenario 2: Under this scenario we assume that SBG revenues decline to $0 in 2015. We assume that capex is ratcheted down from ~$19mm in 2011, to ~$15mm in 2012, and ~$5mm in 2013/14. We also assume that RMBS immediately sells its recent major acquisitions for a fraction of the original purchase price. The DCF value of the SBG segment through 2014 yields a market cap of $291mm, including $17mm in net cash. We then assume that the CRI business is sold for 50% of its original ~$307mm purchase price, the LED business is sold for 50% of its ~$26mm purchase price, and that the Unity Semiconductor business is sold for 75% of its ~$35mm purchase price (higher value assigned to Unity because it is the most recent deal). These businesses yield $193mm in market cap. Together, the DCF of the SBG segment through 2014 and the immediate sale of acquired businesses yields a total market cap of ~$484mm, or $4.11 per share.

But if overall company revenue stays flat, writes Coster, starting in 2014, with new business outweighing existing semi contracts, the stock is worth $7, including litigation victories: “We expect EBITDA margins to gradually expand as litigation expenses decline, yielding a DCF for the baseline business of $6.15. We then include a probability-weighted forecast for litigation cases, which yields an additional $0.90 in equity value.

And then there’s upside with the prospect of a victory in the case against Hynix, and the prospect Rambus will enter new markets:

Hynix and RMBS are required to submit briefings to Judge Whyte in November and a ruling should be forthcoming within months. Though the original award of $397 million could be reduced to comply with Judge Whyte’s “fair and reasonable” mandate (09/12), we think the stock will react positively to any amount awarded to RMBS in excess of $100 million, to which we assign a greater than 50% probability […] There is additional upside for shareholders if the firm’s diversification into mobile applications, LED lighting and cryptography pay off. Rambus has invested heavily in next-generation DRAM solutions (XDR) and memory controllers designed for speed and low-power consumption, which could yield significant growth with new licensees (e.g., Texas Instruments, Qualcomm), though timing and probability of success are difficult to assess and should not be a key consideration for investors at this time. In addition, the recent acquisitions of lighting and optoelectronic patents and a subsequent licensing agreement with GE lighting expose investors to long-term growth opportunities in LED applications (general lighting and CE applications). Finally, the $340 million acquisition of CRI positions RMBS to be a major licensee of cryptography solutions, used extensively in CE hardware, printers, on packaged media, and in financial transactions. If Rambus is successful in diversifying revenues, we believe revenues and earnings will become less volatile and the stock will be awarded a higher multiple.

Note that shares of Mosys (MOSY), another designer of memory chip technology, are up 13 cents, or 4.3%, at $3.17.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.